India’s key inflation indicators diverged directionally in Aug-23:

• CPI inflation moderated from its 15-month high of 7.44% YoY in Jul-23 to 6.83% in Aug-23. While market participants expected a deceleration (towards 7.0-7.1%), the actual print surprised a bit on the downside.
• While being in negative territory, WPI inflation increased to a 5-month high of -0.52% YoY from -1.36% in Jul-23, highlighting the impact of fresh pressures on commodity prices.

Key highlights of Aug-23 CPI inflation

• Sequentially, CPI fell by 0.05% MoM. While that appears modest, it is sharply lower than the series average of 0.70% MoM jump, usually seen in the month of August. Moreover, this is the first time that the index moved lower in August.

• Relief emanated from the food basket, which saw 0.52% MoM fall, led by Vegetables (-5.88% MoM), Egg (-2.97% MoM), and Meat & Fish (-1.70% MoM).

o  Tomatoes (with a ~22% MoM fall) dominated the price move in the Vegetable index, as supply started responding to the sharp build-up in price since Jun-23.

o    Meanwhile, prices of Egg, Meat & Fish suffered on account of adverse ‘Shravan’ seasonality.

• Nevertheless, the decline in overall food inflation was limited due to continued price pressure seen from Cereals, Pulses, and Spices.
  
• The consolidated fuel basket rose by a modest 0.11% MoM. After three months of upward adjustment, the electricity index remained unchanged in Aug-23, while marginal decline in prices of Charcoal and LPG were offset by an increase in Kerosene prices.
  
• Sequential momentum in core inflation (CPI ex indices of Food & Beverages, Fuel & Light, and petrol and diesel items within Miscellaneous basket) remained unchanged at +0.39% MoM in Aug-23. Amidst support from a somewhat favorable base, the annualized inflation under this category moderated to 5.0% in Aug-23, the lowest in the post Covid period. This also indicates that the underlying consumption demand may have lost a bit of its strength.

Key highlights of Aug-23 WPI inflation

• In contrast to CPI, WPI rose sequentially by 0.33% MoM.
  

• The sequential jump was predominantly on account of the Consolidated Fuel index that clocked a sharp jump of 3.31% MoM, led by Crude Petroleum & Natural Gas, Mineral Oils, and Electricity.
  
•  Core WPI (Headline WPI ex indices of Primary: Food, Mfg: Food, Mfg: Beverages, Fuel & Power, and Primary: Crude Petroleum & Natural Gas) saw its first sequential increase in 6-months, albeit modestly by 0.14% MoM.

• On the other hand, the Consolidated Food & Beverages index fell by 0.81% MoM, with correction in vegetable prices, esp. tomatoes and provided relief.
  
  
  

Outlook on CPI inflation

o    The inflation print in Aug-23 offers relief as it confirms the quick mean reversal in price of volatile food items like tomatoes. Going forward, this is likely to gain momentum as one moves towards the favorable food seasonality period in Q3.

o    Specifically, from the perspective of tomatoes, we note that average retail price across key zones has dropped to Rs 41/kg currently from its peak of Rs 136/kg in the first week of Aug.

o    Beyond the food basket, comfort on core inflation continues. We had highlighted earlier that core inflation has aligned with its series average of ~5%. Expectation of moderation in GDP growth post Q1 FY24 should help keep core inflation at comfortable levels.

o    One major development that is yet to be captured in the Aug-23 CPI print is the sharp reduction in price of LPG by Rs 200/cylinder (~18% decline) announced towards the end of the month by the Government. This will reflect in the subsequent month in Sep-23 and according to our estimates would lead to a 30 bps downward move in headline CPI inflation for the month (for the FY24 average CPI inflation, the impact is estimated to be ~20 bps).

Having highlighted the comfort areas, we believe there are reasons to remain cautious:

• Cereals, Pulses, and Spices are going through a strong up-move cycle on account of various factors besides the possibility of a deficient monsoon and its impact on the kharif crop. While the government has already taken mitigating steps towards this, it is unlikely to reverse the hardening trend underway.
• While sequentially rainfall has improved in Sep-23 (on MTD basis, rainfall is currently at a deficit of 6% vs. the long period average) from a record high deficit of 36% in Aug-23, the overall progress has been tardy with skewed spatial distribution. The cumulative deficit in the country till the middle of Sep-23 stands at around 10%. From the LPA. This is set to weigh upon the kharif crop. Overall, it is not only the monsoon performance but the potential impact of El Nino on the upcoming rabi crop that will be a matter of worry for food inflation this year.
  
• International commodity prices have hardened in recent months. Specifically, Crude Oil (India Crude Basket) has jumped from an average level of Rs 75pb in May-Jun 2023 to USD 92 pb in Sep-23 so far. While we do not expect this to translate into hike in retail prices yet because of upcoming elections, it nevertheless diminishes the likelihood of any price cuts, which few market participants were expecting. Moreover, with wholesale prices likely to capture the spillover impact of higher international prices, there could be a second order impact on CPI inflation if the rising trend is sustained.
  
• From monetary policy perspective, while one draws comfort from the fact that impact of outliers on inflation has started to recede (share of number of items within the CPI basket with annualized inflation of more than 6% stood at 30.4% in Aug-23, the lowest in the post Covid period), it would be premature to lower the guard on inflation amidst uncertainty on food and fuel inflation.
  
• Given the balance of risks, we continue to maintain our FY24 CPI inflation estimate of 5.6%, a figure that was upwardly revised last month. This should keep MPC on a prolonged pause, with repo rate at 6.50% through the remaining months of FY24.

Says Suman Chowdhury, Chief Economist and Head-Research, Acuité Ratings & Research "With the moderation in the vegetable prices, the headline CPI inflation has quickly moderated by 60 bps in Aug-23. This is a relief to the central bank and also reflects the steps being taken by the Government to cool down food prices. 

Nevertheless, the concerns on the kharif crop remain due to deficient rains so far in the current monsoon and the potential impact of low reservoir levels on also the rabi crop. Pulses inflation along with cereal inflation continues to be in double digits. We believe that food inflation will continue to be a risk factor over the next six months though the near term pressures have subsided. Further, the rising crude oil prices at over USD 90 pb need to be monitored and while the retail fuel prices may not be increased immediately, its impact is set to be felt particularly in the industrial sector.

India’s wholesale inflation, expectedly, has also started to get firmer after witnessing a contraction for the last 5 months. While the print still continues to be negative at -0.52% in Aug-23, it has tightened from -1.36% in Jul-23 and -4.18% in Jun-23 respectively. Clearly, the rise in food prices has been the key factor behind the lower contraction but fuel and power inflation has also started to gain sequential momentum, given the sharp rise in the prices of crude oil since the middle of August. One important trend in the WPI data is the reversal of the deflationary trend in manufactured products in Aug-23 at +0.14% MoM and such a trend is likely to continue, as reported by the last PMI Manufacturing Survey. We expect WPI inflation to be in positive territory over the next few months, given healthy industrial and consumer demand and the backdrop of increasing prices of crude oil, cereals and pulses.

Given such a backdrop, CPI inflation is set to be in the range of 5.5%-6.5% over the next two quarters and core inflation is also expected to remain sticky. RBI MPC will have limited option but to wait and watch the price scenario till the end of the current fiscal. The status quo in rates is expected to continue with a tightening bias in system liquidity." 

Table1: Overview of key sub-components of inflation

Note:

1) CPI-Consolidated Fuel index includes Fuel & Light and Petrol & Diesel indices from the Miscellaneous basket

2) CPI-Core excludes Food & Beverages and Consolidated Fuel indices from headline CPI

Chart 1: Relief in CPI inflation but inflationary undercurrents still visible